Randy rand seeks blue yonder

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By Cees Bruggemans, Chief Economist of FNB.

You know the tune “Don’t fence me in”?

That’s the Rand for you, and her many emerging and commodity siblings. Not wanting to be tied down, fenced in or curfew-ed.

Not that this is her own hormonal doing. Instead, peer pressure and the pull from big city lights is doing the talking.

So far this process is only 20 months young. If assuming a 2002-2007 trajectory, we are now coming up for late 2003, with Rand peak strength only reached at 5.60:$ two years later in late 2005.

Yet we shouldn’t compare now with then, for THAT was a MINOR US growth/output-gap/deflation scare.

Today sees a much bigger Anglo-Saxon output gap, growth underperformance and disinflation scare. Their interest rates are again near zero, but this time they will be there a lot longer, in addition to which another round of bond purchases looms.

It frightens many overseas people witless as to eventual workouts, so say hello to higher precious metal prices, gold now steaming towards $1400 and platinum towards $1800, but these may be only way stations to even loftier levels given the enormities playing out overseas.

The loose Anglo-Saxon monetary policies are ensuring minimal yields and are encouraging steady outward capital flows in search of remaining yield elsewhere in the world, in the process sinking leading currencies.

This is inviting defensive moves, especially from Japan, but also many lesser countries, pushing yet more liquidity onto the world stage.

Into this happily bubbling cauldron gets pushed the next instalment of aggressive Anglo-Saxon bond buying. In the case of the US probably at a rate of $100bn a month, thereby for at least a year taking care of US budget deficit funding.

Meanwhile, over the next few quarters government bond yields in countries such as the US and Germany are probably on their way towards 1.5%-2% from 2-2.5% today.

In the process, commercial paper yields and mortgage bond rates will all move lower as well, easing commercial and household refinancing terms yet further, easing the ongoing financial adjustment and bolstering consumption and business investment calculations.

Just as Keynes had in mind all those many years ago, but now mostly forgotten in the mists of time.

Anglo-Saxon growth may be anemic for a while, but it would require a new shock to turn persistently negative. In its absence, trundling along is the motto, and eventually picking up speed somewhat.

Between now and that watershed moment, possibly two or more years away, the global tide for the Dollar is down while mostly everyone else will be stronger to the extent that it isn’t successfully resisted.

The ECB may allow benign neglect for the Euro, but not indefinitely. Yet the ECB would like to start normalizing its emergency policy stance from mid-2011. That’s going to be an interesting evolving contradiction to watch.

Japan will want to resist the old-fashioned way, by using monetary looseness. China may accept appreciation, but only gradually. And that leaves another 195 countries grappling with unwanted currency overheating.

The Brazilian Finance Minister last month spoke of global currency wars. Yet that understates a finer point.

Anglo-Saxons are determined to prevent their economies from relapsing. Absent any other still virile policy instruments they are opting for aggressive monetary stances, with secondary fallout on their currencies (which just happens to suit provided it remains orderly).

As to how much more Rand appreciation this implies, that depends on answers to two questions.

Firstly, how much different is this global loosening cycle compared to 2002-2005? I would say much more aggressive and longer. That suggests more appreciation potential still for the Rand and her class siblings.

Secondly, how much countervailing policy action can we still expect from our policymakers and their class peers elsewhere? This is not easy to read.

One option is to lower our still high interest rates yet further, as also happened in 2003-2005, as inflation and growth undershoot and output gaps disappoint by lingering too big for too long.

But that may only compensate for Rand strength, with still lower rates supporting the economy, thus neutralizing the corrosive Rand impact.

One or more interest rate cuts still could thus underpin the economy, but probably not prevent further Rand firming.

That leaves unorthodox intervention options, from buying more reserves (expensive), forward swap options, transaction taxes (ineffective?), easing exchange control (no appetite beyond ‘prudential’ limits), heavy verbal intervention (ignored) and what have you.

As bottom line we probably don’t have the means to get too heavy handed for too long. Any intervention may therefore dent the Rand’s spiraling rise but it may not fully prevent it.

This gives us in coming months a 6-7:$ and 9-10:€ trading ranges. This should be regularly reviewed, given the speed of events globally, in need moving our goalposts (yet firmer).

Post-2012 we may encounter some milder global weather, allowing the Rand naturally to lose some of its recent overvaluation, just as it did post-2005.

But the exact playout is shrouded in futuristic mists as global events and policymakers need to show their hands.

Source: Cees Bruggemans, First National Bank, October 11, 2010.

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